Case Problem

Case Problem

T HE C LEAN C LOTHES C ORNER L AUNDRY

When Molly Lai purchased the Clean Clothes Corner Laundry, she thought that because it was in a good location near several high-income neighborhoods, she would automatically generate good business if she improved the laundry's physical appearance. Thus, she initially invested a lot of her cash reserves in remodeling the exterior and interior of the laundry. However, she just about broke even in the year following her acquisition of the laundry, which she didn't feel was a sufficient return, given how hard she had worked. Molly didn't realize that the dry-cleaning business is very competitive and that success is based more on price and quality service, including quickness of service, than on the laundry's appearance.

In order to improve her service, Molly is considering purchasing new dry-cleaning equipment, including a pressing machine that could substantially increase the speed at which she can dry-clean clothes and improve their appearance. The new machinery costs $16,200 installed and can clean 40 clothes items per hour (or 320 items per day). Molly estimates her variable costs to be $0.25 per item dry-cleaned, which will not change if she purchases the new equipment. Her current fixed costs are $1,700 per month. She charges customers $1.10 per clothing item.

What is Molly's current monthly volume?

If Molly purchases the new equipment, how many additional items will she have to dry-clean each month to break even?

Molly estimates that with the new equipment she can increase her volume to 4,300 items per month. What monthly profit would she realize with that level of business during the next 3 years? After 3 years ?

Molly believes that if she doesn't buy the new equipment but lowers her price to $0.99 per item, she will increase her business volume. If she lowers her price, what will her new break-even volume be? If her price reduction results in a monthly volume of 3,800 items, what will her monthly profit be?

Molly estimates that if she purchases the new equipment and lowers her price to $0.99 per item, her volume will increase to about 4,700 units per month. Based on the local market, that is the largest volume she can realistically expect. What should Molly do?

[Page 27 ( continued )]

Case Problem

T HE O COBEE R IVER R AFTING C OMPANY

Vicki Smith, Penny Miller, and Darryl Davis are students at State University. In the summer they often go rafting with other students down the Ocobee River in the nearby Blue Ridge Mountain foothills. The river has a number of minor rapids but is not generally dangerous. The students' rafts basically consist of large rubber tubes, sometimes joined together with ski rope. They have noticed that a number of students who come to the river don't have rubber rafts and often ask to borrow theirs, which can be very annoying. In discussing this nuisance, it occurred to Vicki, Penny, and Darryl that the problem might provide an opportunity to make some extra money. They considered starting a new enterprise, the Ocobee River Rafting Company, to sell rubber rafts at the river. They determined that their initial investment would be about $3,000 to rent a small parcel of land next to the river on which to make and sell the rafts; to purchase a tent to operate out of; and to buy some small equipment such as air pumps and a rope cutter . They estimated that the labor and material cost per raft will be about $12, including the purchase and shipping costs for the rubber tubes and rope. They plan to sell the rafts for $20 apiece, which they think is about the maximum price students will pay for a preassembled raft.

Soon after they determined these cost estimates, the newly formed company learned about another rafting company in North Carolina that was doing essentially what they planned to do. Vicki got in touch with one of the operators of that company, and he told her the company would be willing to supply rafts to the Ocobee River Rafting Company for an initial fixed fee of $9,000 plus $8 per raft, including shipping. (The Ocobee River Rafting Company would still have to rent the parcel of riverside land and tent for $1,000.) The rafts would already be inflated and assembled . This alternative appealed to Vicki, Penny, and Darryl because it would reduce the amount of time they would have to work pumping up the tubes and putting the rafts together, and it would increase time for their schoolwork.

Although the students prefer the alternative of purchasing the rafts from the North Carolina company, they are concerned about the large initial cost and worried about whether they will lose money. Of course, Vicki, Penny, and Darryl realize that their profit, if any, will be determined by how many rafts they sell. As such, they believe that they first need to determine how many rafts they must sell with each alternative in order to make a profit and which alternative would be best given different levels of demand. Furthermore, Penny has conducted a brief sample survey of people at the river and estimates that demand for rafts for the summer will be around 1,000 rafts.

Perform an analysis for the Ocobee River Rafting Company to determine which alternative would be best for different levels of demand. Indicate which alternative should be selected if demand is approximately 1,000 rafts and how much profit the company would make.